Discussion 5

Financial Ethics

Learning Objectives

After completing this chapter, you should be able to:

• Describe the common dilemmas that accountants and financial officers face. • Consider how commercial conflicts of interest may arise in preparing accounts and financial reports, and examine whether such conflicts are best dealt with by the government or the marketplace.

• Understand some of the ways companies cheat on financial reports. • Assess the advantages and disadvantages of insider dealing. • Explain the problem of rogue trading. • Describe the various regulations concerning financial practice.

Associated Press/Peter Morgan

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CHAPTER 7Section 7.1 Introduction

Contents

7.1 Introduction

7.2 The Ethics of Accounting

Impartiality Berle and Means Versus Henry Manne: Two Views of Corporate Corruption Cooking the Books Transfer Pricing and Costing The Ethics of Deception U.S. Accounting and Reporting History

7.3 Commercial Conflicts of Interest

The Buyer-Beware Principle Complex Products Should Customers Do Their Homework?

7.4 Insider Trading

Insider Trading Defined Examples of Insider Trading The Free Market Perspective An Issue of Fairness Legal Theory of Misappropriation

7.5 Rogue Trading

Example of Rogue Trading: Nick Leeson What Can Be Done?

7.6 Conclusion

7.1 Introduction Recently, a steady stream of major financial scandals have rocked the business world. At one point, Enron (in the United States) was one of the world’s largest utility companies. Within a year, a massive accounting fraud was uncovered, leading to its bankruptcy. The U.S. communications company WorldCom was found to have been covering a $3.8 billion fraud, inflating its asset values to make it look financially healthier than it really was. More recently, the American businessman Bernard Madoff defrauded some 4,800 clients—including many charities—of $65 billion.

Accountants are trained professionals who are accredited and licensed to provide professional services concerning the accounts, audits, and reporting of corporations’ finances. Many are mem- bers of professional organizations, such as the American Institute of Certified Public Accountants, that have ethical principles or codes of professional conduct that members pledge to adhere to. Like medical professionals, they are expected to live up to a professional reputation that has developed over many decades. But innovation in the business world, as well as globalization, has

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put increasing pressures on accountants, auditors, and CEOs that can affect their professional judgment and lead to accounting fraud. Such fraud is costly—in fact, it is estimated to cost the U.S. economy over $300 billion annually.

In the wake of notable fraud cases such as the ones mentioned earlier, the financial profes- sion has been under intense media, regulatory, and internal scrutiny to make sure that financial professionals behave ethically. It even became popular for MBA graduates to swear an oath to uphold ethical conduct, in order to give the financial professions credibility similar to that of health services (MBA, n.d.). Yet so-called white-collar crime continues. It includes various types of financial fraud, such as embezzlement, insider trading, rogue trading, tax evasion, money laun- dering, and more.

This chapter reviews the ethical temptations that sway accountants and other financial officials away from the professionalism expected of them. We will start by taking a brief look at the laws that affect accounting and reporting.

7.2 The Ethics of Accounting Business is run on numbers. The collection, measurement, recording, and communication of finan- cial information is the foundation of accounting; these numbers in turn help owners and investors make financial decisions regarding setting up, expanding, contracting, buying, and selling businesses.

Numbers are supposed to represent objective values. Recall from Chapter 1 that some ethicists believe that moral values are objective, universal, and unchanging. We would normally imagine that numbers are objective and that financial professionals would have no trouble in assigning agreed-upon values. But this is not the case. Turnover and the quantity of sales are objectively measurable, and there can be little argument about them. However, financial professionals also must put values on assets such as property and inventories, as well as offer predictions about future sales and profits. Here is the great dilemma they face: If they stick to reporting what they can know without question, there will be very little to report. However, if they begin to place val- ues on things they do not know with certainty, they can exaggerate or underplay the corporation’s value. This has enormous repercussions on the company’s financial health.

Consider a company that owns a retail unit that it paid $1.5 million for in 2005. The property is an asset that could be sold if the company had to pay a debt. Property values have fallen in the area since 2005, and the accountant knows that the company would not get $1.5 million now, should it sell the company. But what value should be put down? One accountant may suggest $1.2 million, another $1 million. If the company wished to take out a loan, the higher value would be more useful, but if it wanted to reduce its taxable assets, the lower figure would be more useful. There is no right answer here.

Generally, accountants agree to be conservative in making up values, but what conservative means to one accountant may be very different from what it means to another. The problem is that financial numbers are not always objective; there is a great deal of subjectivity involved in producing them. As you can see, accountants can miscommunicate the reality of a company’s financial health through their use of numbers, or even lie about a company’s state of affairs.

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To increase the depth of the problem, many managers who are not financial minded have an “accounting phobia,” which means that financial irregularities, cor- porate problems, and investment opportunities can all be easily missed (Ittelson, 2009, p. 3). If most people are illiterate in the terminology and principles of finance and accounting, it is difficult to judge what is happening, never mind whether the company is acting ethically. Honest mistakes and insidious fraud may develop swiftly without many people knowing.

Not surprisingly, there is therefore a critical element of fiduciary trust that employers and employees, shareholders, and other stakeholders must have in the financial profession. Fiduciary trust implies hav- ing a faith that the accountants, auditors, and finan- cial officers will not lie, cheat, steal, or intentionally misrepresent the company’s financial health. It is this role of trust that the accounting profession is keen to stress. But the problem is that accounting, and hence financial reporting, cannot be precise.

Impartiality

One ethical practice that is often required in the finan- cial professions is impartial oversight. The financial officer dealing with the daily, monthly, and annual reports needs to be removed from any self-interest in assessing the monetary flows. Impartiality involves stepping outside of one’s current position and thinking about what should be reported as if any- one else from the profession were going over the books. However, pressures of the corporate world can undermine professional values such as impartiality as well as due diligence (checking all the key facts properly, rather than assuming that they are correct). When there is pressure to get a deal or to secure a line of funding, self-interest may overwhelm professional codes of conduct, leading to unethical behavior.

Commentators differ on whether the marketplace can look after its own problems or whether government intervention is necessary. We will now look at two theories: one that is very skeptical of businesses’ ability to run without trying to defraud people, and one that sees the marketplace as sufficiently self-regulating.

Berle and Means Versus Henry Manne: Two Views of Corporate Corruption

Two opposing positions on corporate corruption have been offered by, on the one hand, the busi- ness ethicists Adolf Berle and Gardiner Means and, on the other, by their opponent Henry Manne.

What Would You Do?

You are in charge of a company with annual sales of $5 million. You have an opportunity to secure new lend- ing from banks that could propel your company’s sales into the $10 million bracket. Deep down you feel that the company is reaching a plateau in sales, and you are concerned that the future will not be as rosy. Competition is increasing in the industry, and there has been an increase in staff turnover. The new loans could indeed work mir- acles, and if the sales do not actually take place, you could sell the company with its new financing and leave the problem to someone else. Either way, your own reputation would be intact.

1. Given this information, what would you do?

2. Should you discuss your worries that the company has seen its peak, or keep them to yourself until the funding is secured?

3. Do you think that honesty always pays?

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One view favors government regulation, whereas the other favors leaving companies alone, as any mistakes they make will be punished sufficiently in the marketplace through customers’ leaving or other companies’ buying them out.

Berle and Means: We Need Regulation Berle and Means held a cynical point of view that business managers are playing a game to defraud customers and other stakeholders as well as they can. In the absence of good checks and balances, financial managers cannot be trusted to act ethically in how they present themselves and their financial books. They offered three reasons for this:

• The people who run corporations seek to exploit the workers as well as they can to keep costs low, which helps to raise profits.

• They try to reap as much profit for themselves from the company as possible in large bonuses and dividends.

• Their accountants and auditors also get caught up in self-serving behavior and are likely to turn a blind eye to improper procedures (Berle & Means, 1932).

The resulting corrupt corporate culture snares everybody in conflict, as each tries to look after his or her own financial interests. Managers are looking for higher salaries, and accountants are looking for renewed auditing and reporting contracts. There is also the problem that corporate culture is generated from the top. If the executives are acting outside their professional ethics, the ethical tone of the corporation may then be tainted. Junior officers may thus think that cheating or covering up mistakes is acceptable. As each section of the business pursues its own interests, it can produce the kind of sick corporate culture that eventually undermined the utility giant Enron.

For Berle and Means, if business cannot be trusted to regulate itself, and if the financial profession regularly loses the trust people have in it because financial professionals are constantly seeking their own self-interest, then there is a duty for the government to regulate and to control account- ing procedures to ensure transparency and universal auditing principles and rules.

Manne: The Marketplace Can Decide An alternative position was developed by the free-market supporter Henry Manne (2009a). For Manne, businesses cannot hide falsehoods for long without being found out. When self-interested behavior turns to deceiving the public, any chance of profiting from the deception is eventually lost. Manne argued that investors have a vested interest in scrupulously examining the financial statements and cash flows of corporations in which they hold or wish to hold investments. So any fraud or strange accounting procedures are likely—or even bound—to be discovered. He offered two reasons for this:

• Fraudulent reporting is costly to businesses and shareholders, and those guilty of fraud run the risk of long-term lawsuits from aggrieved investors and even the dissolution of the company.

• If managers act against the interests of shareholders, they are likely to drive the share price down. As the share price falls, the self-serving managers have opened their company up for a takeover or merger (Manne, 2009b).

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Manne argued that the threat of being bought out is ever present in the marketplace, so exter- nal regulation beyond normal litigation against criminally fraudulent managers is unnecessary. Although directors can face a personal incentive to camouflage problems or exaggerate incomes, there is also an incentive on the part of investors and shareholders to have the numbers verified as independently as possible. And if CEOs and chief financial officers (CFOs) try to deceive, they may lose not only their reputations, but also their business.

We now turn to the particular methods that financial officers may use in deceiving shareholders, the government, and the public: cooking the books and transfer pricing and costing.

Cooking the Books

Since an element of the financial industry involves using subjective financial values, there is always an incentive to use values that serve particular people. Here we will look at the nature and pos- sible solutions of the most common problem, namely cooking the books. To cook the books is to knowingly falsify a company’s financial statements, which is illegal in the United States. It includes several unethical practices, some of which are identified here:

• Accelerating revenues is when a company brings forward future receipts as if they were earned today.

• Delaying expenses is when a company books its current expenses in the future. • Other income or expense is a term used when a company hides excess incomes or

expenses. • Pension plans are used by companies to deflate or inflate their financial position: If a com-

pany runs a pension plan and the fund is doing well, it can reduce payments into the plan to make its costs look better than they are.

• Off-balance-sheet items are used when a corporation wishes to hide in other corporations it may own liabilities and expenses that it does not want reported.

In each of these examples, the intention is to deceive. Cooking the books is not the same as creative accounting, which is legal and enables accountants and directors to record transactions in different ways for different purposes. With creative accounting, the transactions, assets, and liabilities are real rather than fictitious or sleights of hand.

The world of deceptive accounting is complex, but it often comes down to the simple ideas of falsi- fying income (e.g., by selling a product to yourself), lowering expenses incurred (and thereby mak- ing profits look higher than they are), hiding losses (by calling them profits), or exchanging assets across the company. As with other crimes, there is a belief that the officers will not be caught, that the lie is an intermediate one until things improve, or that it is worth it for the officer’s personal gain or indeed for the benefit of the company and its stakeholders. For example, consider the case of former Computer Associates CEO Sanjay Kumar—which we will examine in detail later—who acted very charitably in other areas of his life but committed fraud, perhaps in order to benefit the company as a whole. This is the ethical position of the utilitarian, who believes that the ends sought may justify the means used, so that a deception or a lie that produces good results is mor- ally acceptable. If deception creates more wealth and jobs, the utilitarian would applaud it.

But this is an argument that does not sit well with professional bodies. Things do not always turn out the way people expect. To act honestly from the beginning makes more sense than to act in the hope that the discrepancies, lies, and fraud will be ignored once great results occur. When

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there is an intention to deceive, it does not matter what results are expected: The problem lies in the intention to do wrong.

In the following two examples, we look at the frauds committed by Computer Associates and Enron. The first company survived, but the second did not.

Example of Cooking the Books: Computer Associates As the CEO of the U.S. software company Computer Associates (now CA Technologies), Sanjay Kumar found out what happens when a manager uses fraudulent financial practices to deceive

others. In 1999 and 2000, Kumar inflated the company’s sales fig- ures by drawing on present quar- terly sales figures and posting them as if they had occurred in the past (a technique known as the “35-day month”). Once an investigation began, Kumar bribed a witness. He was subsequently found guilty of fraud and obstruction of justice and was given a 12-year prison sen- tence. Computer Associates also had to pay shareholders $225 mil- lion for the losses it incurred based on the deception. The short-term gain of appearing to have stronger sales figures was quickly wiped out by Kumar’s act (Merced, 2006). Computer Associates survived, though it rebranded itself as CA Technologies and sought to move on from Kumar’s misconduct.

Example of Cooking the Books: Enron The story of Enron is a complex one. The company grew quickly and fraudulently—it became the United States’ seventh largest company in 15 years, employing 21,000 staff and operating in 40 countries. Following the deregulation of energy markets in the 1990s, Enron extended its busi- ness into different fields. For an economist, deregulation means the removal of legal barriers that inhibit competition, but for Enron it meant the freedom to deceive investors and employees about how it was faring financially. Losses were not properly aired, earnings were misrepresented, and executives embezzled funds and announced an energy crisis that did not occur. The company was heading towards bankruptcy when, in 2001, whistleblower Sherron Watkins penned an anony- mous note to CEO Ken Lay warning that the company would “implode in a wave of accounting scandals” (quoted in Carozza, 2007). Lay apparently sat on the information while the company headed towards bankruptcy. The previous CEO, Jeff Skilling—who had left earlier in the year—sold his Enron stock before the price began to fall. Skilling was indicted on several counts, including insider trading and securities fraud. Lay was later convicted of conspiracy to commit securities fraud, which led to the downfall of the company. He died before being sentenced for his crimes.

Associated Press/Louis Lanzano

In this 2006 photo, the former CEO of Computer Associates, Sanjay Kumar, leaves a federal court after being found guilty of fraud and obstruction of justice. He was given a 12-year prison sentence and fined $8 million for his part in the company’s accounting scandal.

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Enron’s auditing company, Arthur Andersen, also acted as its consultancy firm, which blurred the lines of independent assessment, allowing problems to be overlooked. Even though Arthur Andersen was even- tually acquitted of wrongdoing by the Supreme Court, in 2005, the damage was done. After initially being found guilty of obstructing justice, the company quit operating as a firm and its employees left to work with the other major accountancies.

Transfer Pricing and Costing

A further pair of methods used by companies to alter their financial positions are transfer pricing and trans- fer costing:

• Transfer pricing involves inflating revenues by making it look like the company or parts of it generate higher revenues than is actually happening.

• Transfer costing involves shifting revenues from departments facing high tax rates to those facing lower taxes. Transfer costing is legal but not necessarily ethical.

Transfer pricing is a common problem across the financial world. Let’s say Ford wants some consul- tancy work done with its production-line managers. It can either buy in services from another com- pany or use its own team from its headquarters in Detroit. Either way, it must pay a fee. What fee is

charged depends on what the finan- cial officers wish to report. Charging above the going rate can make the Ford consultants look more profit- able than if they sold their services on the market, thus inflating reve- nues. Using transfer pricing like this becomes a problem if the company is creating the appearance of higher revenues through buying from itself.

Transfer costing, on the other hand, is particularly attractive for multinational corporations seek- ing to minimize their tax burden by sheltering funds. A 2011 sur- vey showed that multinationals were being increasingly targeted for auditing by governments. The audits highlighted the prevalence of transfer costing (Cohen, 2011). In

Associated Press/Michael Stravato

In this 2004 photo, former Enron CEO Ken Lay is led into court. Lay was later con- victed of conspiracy to commit securities fraud, which led to the downfall of the company. He died before being sentenced for his crimes.

Associated Press/Louis Lanzano

In this 2005 photo, Adelphia Communications founder and for- mer CEO John Rigas leaves a federal court. Sentenced to 15 years, Rigas was convicted of hiding billions of dollars of company debt and using company funds for his own personal uses. The com- pany filed for bankruptcy in 2002 as a result of his actions.

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fact, the international charity Christian Aid estimated that developing countries are losing $160 billion of tax revenues annually from transfer costing (Sikka, 2009).

A conflict then arises between those who believe that corporations should pay their fair share of taxes and those who believe that companies should seek to minimize their costs, including taxes, for the benefit of shareholders. In a world of different tax brackets, it makes sense that companies seek to minimize their tax burden to improve their earnings; but is it right for them to do so?

The problem of transfer pricing and costing is compli- cated by the international structure of many corpora- tions today. Consider a product that is researched in Switzerland, produced in Japan, and then sold in the United States. Where should the profits be taxed? Tax evasion occurs when an individual or a corporation actively hides or lies about its revenues, whereas tax avoidance is a legal strategy using transfer costing and other accounting tools to minimize tax payments.

Cooking the books and transferring funds to make the company look better or to avoid higher taxes are all about deception. Deceiving people is generally con- sidered wrong, but there are those who argue that deception can play a positive role. We will look at that argument next.

The Ethics of Deception

Deception is a falsification of reality, and ethicists would stress that such falsifications cannot be sus- tained or that they are immoral and must be avoided. Following Henry Manne’s argument from before, investors have an incentive to check companies’ accounts. Therefore, financial irregularities will sooner or later emerge, or whistleblowers will point out what is occurring. Otherwise, to actively deceive someone is an immoral act, for it involves treating other people as a means to an end—it goes against the moral fiber of a civil society.

But could ethics support cooking the books? The ethics of duty would categorically say no. A direc- tor has a duty to stakeholders to be honest, and that honesty is not just the best policy, it is the only policy. Recall from Chapter 1 that the Golden Rule is something that anyone would choose in the same situation—no exceptions. So if a person altered the financial books to make the corpora- tion look better for whatever reason, they would be acting unethically.

On the other hand, a utilitarian who looks to the consequences of an action might take a more flexible approach. If a deception benefits a great number of people, then it could be an excusable strategy. And this is what challenges professional integrity across the financial profession. For

What Would You Do?

Say you are a CFO for a U.S. company earning millions in profits across Africa. You have the choice to employ trans- fer costing to avoid high local taxes and instead send the money back to the United States. There, the tax rate is lower and the profits will pay high dividends to U.S. pension funds. You are aware that Americans will directly benefit from the transfer. In addition, the company will gain extra investment funds if it looks good to U.S. banks. However, the African nations will lose tax revenues, which they could use to maintain their infrastructure and improve their education and health systems. You always complain that the African nations have problems of corruption and poor infrastructure, which higher tax revenues could help to alleviate.

1. Would you express your ideals to help the local economies by con- tributing more taxes, or would you instead look after the interests of U.S. investors?

2. Do you think companies generally should be paying local taxes?

3. Would you be in favor of all com- panies around the world paying the same tax rate?

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instance, if the intention is to secure a deal or to attract more investment that in the long run will pay off with higher profits and more wealth creation, then the utilitarian might accept a short- term deception.

But how long is the short term? In business, all is in flux: Markets change, managers come and go, financial situations alter both within a market and in the broader economy. This provides two strong incentives to exploit short-term deception:

• If a manager moves from company to company, any irregularities he generates to improve his position or department can be hidden for the short term. By the time they are uncov- ered, the manager may be long gone.

• The manager may sincerely believe that inflating revenues now will be sustained by a rise in the market and higher future cash flows.

The first is the immorality of the criminal who tries to get away with fraud and move on before he or she is caught. It is the kind of fraud that credit card thieves perpetrate by moving from state to state. The second is ethically harder to pinpoint, and indeed, expecting future cash flows is what business depends on.

For example, say an auto dealer takes on a dozen new cars in the belief that she will be able to sell them in the next month, earning an income before she has to pay off the supplier. The market has been good and she believes that her revenues will continue to increase. This is an integral element of business planning, but markets can suddenly turn and leave the trader high and dry. It turns out that she is suddenly left with a large outstanding debt and no cash flow to cover her expenses. She has to adapt—perhaps by borrowing for the short term, dropping the prices of the cars on her lot, or advertising aggressively to attract customers—or facing bankruptcy.

In the ever changing marketplace, businesses have to make many assumptions about what will happen as well as about what is happening. The auto dealer’s intention to make future monies can be understood. If she sincerely believed that higher revenues would occur, then she cannot be wholly condemned for acquiring greater stock. She can be chastised for naively assuming that the future will be like the past and for not researching her market better, but that is something all investors can be guilty of.

If she worked alone, we can say that the fault was hers and the pain of struggling to adapt was hers alone, too. But if she employed several people and had made promises to other suppliers, her action has broader effects. When a company employing thousands gets its future expecta- tions wrong, a lot of people can suffer. Some will say that that is the nature of business; others will demand that businesses be more conservative about their behavior because risky ventures harm people.

U.S. Accounting and Reporting History

In response to the stock market crash of 1929, the federal government introduced a series of reforms to the financial, banking, and accounting industries. Since then, the government has tried to calm the excesses of capitalism through regulations, while the accounting profession has pro- duced its own board to oversee professional standards.

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Early Reforms In 1934, the Securities Exchange Act set up the Securities and Exchange Commission(SEC) under the chairmanship of U.S. businessman Joseph Kennedy. The SEC was charged with setting up stan- dards to govern accountancy and corporate reporting. It preferred, however, to delegate the task of actually creating accounting standards to the private sector, as long as that sector showed its trustworthiness in its procedures.

In response to mounting concerns, the Financial Accounting Standards Board (FASB) was set up in 1971 by the profession to produce stricter professional standards and codes of conduct. The board’s mission has been to keep full government regulation off the profession and to set independent standards by which accounting and reporting are gov- erned in the United States. These standards are known as generally accepted accounting principles (GAAP).

Sarbox Accounting scandals after 1971 encouraged Congress to introduce more regulation, such as the Sarbanes– Oxley Act of 2002 (SOX or Sarbox). The act was designed to reduce the ability of companies to amend their fig- ures to make them look more appealing to investors. Some have argued that the act provides greater trans- parency in reporting and permits investors to compare different companies on similar grounds (Henry, 2007). Others have complained that the extra rules and pro- cedures hamper American companies in international competition and that the “check-box” mentality of the act has actually distracted businesses from the very ethical principles it was supposed to foster (De Coster, 2002). In fact, in a survey of company directors, over half thought the act should be repealed (Evans, 2006).

Cooking the books and transfer pricing and costing are examples of self-interested behavior specifically in accounting. Next we will look at some other key areas of conflict and ethical problems that arise in the finance profession.

7.3 Commercial Conflicts of Interest A conflict of interest occurs when an agent who must act impartially or loyally to successfully complete a job has a competing financial or other reason not to do so. The agent in this case may be a director, an employee, or a manager who works for one corporation, for example, but has financial ties to a competing organization. Or it can be a person in a position of authority who has

Associated Press/J. Scott Applewhite

In this 2002 photo, President George W. Bush signs the Sarbanes–Oxley Act, a new law changing accounting practices and imposing tough penalties for violators. With Bush are (right to left) Senate major- ity leader Tom Daschle, Senate minority leader Trent Lott, Senator Paul Sarbanes, and Representative Mike Oxley.

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conflicting responsibilities. Additionally, there is also the consideration of who is responsible for acknowledging and resolving the conflict. Should the responsibility fall on the shoulders of corpo- rations or consumers? That is, should professionals disclose their conflicting interests in the ser- vices they offer, or should consumers be expected to work that out? The conflict of interest is the simplest problem that finance officers and accountants face. It is not always apparent, however, when a conflict arises, so this section outlines some of the key points to consider.

The Buyer-Beware Principle

A simple example of a conflict of interest is a salesperson encouraging a customer to buy a service. Obviously, the salesperson gains from the sale. Generally, people would not consider such an obvi- ous self-motivated move as an ethical problem. The job of a salesperson, after all, is to sell, and the customer knows this. But when advice on a product is given that appears impartial but is in fact underpinned by a self-serving desire to sell the product, then there can be a conflict of inter- est if the seller does not express this commercial interest. In the world of business, the principle of “buyer beware”—also known by the adopted Latin expression caveat emptor—is said to rule, and most of the population would be presumed to understand that people who are trying to sell you a product have a financial interest in doing so.

But consider another more complicated scenario. When stock markets are doing well, advice is often given freely—by TV pundits, for example—on what stock and investments to buy. Such pun- dits are not giving impartial advice, for they are generally selling brokerage services, so there is a conflict of interest that is easily spotted. However, when stock prices fall and the pundits’ expecta- tions fail, customers may then feel aggrieved and want some form of compensation. Lawyers then replace the stockbrokers, explaining how they can help clients sue the brokers. In turn, the lawyers are seeking to sell a service and attract clients. For instance, in the boom of 2000, CNBC had rep- resentatives on from the investment companies Merrill Lynch and Morgan Stanley to give advice on stocks. Following the crash, such experts were replaced by lawyers such as Jacob Zamansky, advising on suing the stockbrokers (Sheehan, 2002). Ultimately, the stock advisers and the lawyers were both selling services.

Caveat emptor becomes more intricate here. It is not always obvious that people giving financial advice are in fact speaking impartially. Many advisers are connected to the products that they sell, and a lawyer selling legal services is similar to the clothes retailer advising on clothes. But the connection is not always obvious. For instance, there is the principle of disclosure, which says that an adviser should explain personal or financial interest in the products. This is not required in a transaction as simple as purchasing a pair of jeans from the owner of a store, but it becomes increasingly important with more complex products.

Complex Products

So what if the product offered is complex, such as a mortgage, an insurance policy, or some shares or their derivatives? Accountants and financial advisers offer complex services that are often dif- ficult or even impossible for the general public to understand. That is the reason there are licens- ing bodies guiding professionals on their codes of conduct, to help them avoid conflicts of interest and to act impartially (Brooks, 2001). Indeed, since the 1990s, accountants have increasingly been taught ethics in their courses. They have been encouraged to recognize when an ethical dilemma is occurring and then to consider and evaluate alternatives and propose a solution (Stuart, 2004).

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Ethics teaches us that impartiality is generally good. In educating people, professionals should be advising as if from a third-party perspective rather than from the perspective of their own inter- ests, simplifying the procedures or contract where appropriate and at least explaining what they have to gain from the service. Expert advice is naturally useful, but even if accountants are trained in ethical analysis, how can customers know if they are getting sound, impartial advice?

In recognizing that true impartiality is difficult, some companies have developed options that converge on impartiality. For instance, many Web sites assist people in gaining knowledge about many products and service providers and in cutting through the jargon that often attends complex services. Consider the stock market: Nowadays, some online stock brokerages prefer to offer their clients a range of opinions, drawing on the recommendations of many analysts (averaging a buy or sell recommendation, for instance), or they may sell a higher quality report to subscribers that reflects their own research into the market.

If the complexity of a deal is still baffling, then expert advice can be bought, just as a lawyer’s expertise can be in, for example, creating a will, and the parties’ advice can be compared. Critics could complain that such advice would not come free, and that is true. But then is free advice— freely given by neighbors and friends without any formal training—any good?

Professionally, advisers should disclose any interest they have in providing advice, since that is the honorable, impartial, and honest thing to do for potential clients. Impartiality involves separating advice from any potential for commercial gain, whereas disclosure is admitting that there is a com- mercial interest in what is being offered, such as mortgage or debt advice.

Should Customers Do Their Homework?

But there is another angle that needs to be considered: Are customers always at fault when they fail to do their homework? A free-market proponent would say yes, the buyer should be aware and people should be responsible for their own decisions. After all, only they can learn from their own mistakes, and if they chose to avoid studying a deal or employing an expert, that is their own fault.

However, it can also be recognized that people can be swayed by their emotions and can be easily talked into decisions that they would not enter into in a more rational frame of mind. Consider a medical company offering a treatment to cure cancer. Most people would jump at the chance of saving a loved one’s life, yet they may end up paying thousands in bills for the treatment without being told of alternative, cheaper treatments. Or consider an insurance company offering to pro- tect a family from financial disaster but not explaining the small print that certain issues are not covered. Few people read the small print, and few would assume that they need legal advice on insurance. Unfortunately, the reality of legislation, regulations, and the tax code is that their com- plexity means that companies have to write complex contracts that only specialists can interpret. There is no easy solution to making things simpler.

One solution to the problem, though, is education. Professionals have a duty to explain matters clearly to their clients and to point out potential problems with a contract. Failure to do so is a lapse in professional conduct. Customers can always ask what the jargon means, and they do have a responsibility to read through contracts or employ legal counsel for large financial commit- ments. People may avoid reading the small print or shun professional advice as being expensive, but the costs are generally worth it in the long run: Accountants often say that their fee should cover the taxes that you would have paid if you were doing your own returns.

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CHAPTER 7Section 7.4 Insider Trading

7.4 Insider Trading Another white-collar financial crime that hits the headlines and attracts media attention is insider trading. In this section, we will briefly look at the laws governing insider trading, review famous insider-trading cases, and consider whether insider trading is actually a force for good.

Insider Trading Defined

Insider trading occurs when some- one has information that the rest of the public does not have and then acts on that information to deal in stocks to make a personal gain. Insider trading became well known in the 1980s, with criminal charges being filed against busi- nessmen like Michael Milken and Ivan Boesky and later in the 2000s against corporate officials from Enron. It has remained in the pub- lic eye with famous cases against media magnate Martha Stewart in 2004 and against former hedge- fund manager Raj Rajaratnam, who in 2011, was sentenced to 11 years in prison for conspiracy and securi- ties fraud.

Examples of Insider Trading

The SEC introduced laws against insider trading in 1934 on the basis that insiders had a fiduciary duty to shareholders. Under the laws, any company officer, director, or shareholder owning more than 10% of the company is defined as an insider and is therefore liable if he or she should act to profit from the inside. Examples include advance knowledge of something that would highly benefit the company’s share price, foreknowledge of a dividend cut, and unanticipated expenses.

In 1980, following a Supreme Court ruling, the SEC promoted the principle that insiders should not trade on private information on the grounds that their action is a form of fraud, because insiders have a fiduciary duty (a contractual loyalty) to people buying or selling stock in the company. In other words, they must not trade while the information remains private (Dalley, 1998). Let us look at three examples of insider trading.

Example of Getting Away with Insider Trading: Vincent Chiarella Vincent Chiarella worked in a printing company, setting up sensitive financial reports. From the information he saw—information that was not yet in the public domain—he was able to work out

Associated Press/Jin Lee

In this 2011 photo, Galleon Group founder Raj Rajaratnam leaves court after being found guilty of conspiracy and securi- ties fraud. He was sentenced to 11 years in prison.

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the identities of corporations involved in takeover bids. He therefore bought shares in the compa- nies before the takeover bids were made public, earning $30,000 from his trades.

The SEC attempted to prosecute him for insider trading, but the Supreme Court supported Chi- arella, arguing that he had no fiduciary duty to any shareholders, nor was he an insider. He had nonpublic information, but that did not necessitate any disclosure (Chiarella v. United States). From the case, the fiduciary duty of insiders was thus highlighted

Example of Insider Trading: Michael Milken and Ivan Boesky The U.S. stock trader Ivan Boesky was the first big fish that the SEC caught for insider trading. Boesky was a trader who dealt based on inside information to become one of Wall Street’s most successful dealers. His reputation for dealing with inside information was known before the SEC moved in. They made a deal with him to continue in his position as long as he informed on others. Eventually he was arrested for his crimes, and he pointed a finger at Michael Milken.

Milken was a prominent whiz-kid investor who had helped finance many well-known U.S. corpora- tions, such as Barnes and Noble, CNN, and Time Warner. His inno- vative techniques earned him mil- lions, but they also attracted the watchful eyes of the SEC. Although Milken was never indicted on insider trading, he spent 22 months in prison for various securities frauds and accounting irregulari- ties. Since leaving prison, Milken has sought to rehabilitate his rep- utation and put his energies and funds into curing prostate cancer, which he suffered from in 1993.

Example of Insider Trading: Martha Stewart Businesswoman Martha Stewart was prosecuted in a high-profile case for selling stock in 2001 based on insider information. Prosecutors argued that Stewart was told by a friend that his com- pany, ImClone, had had its cancer drug rejected by the Food and Drug Administration. Stewart’s stockbroker, Peter Bacanovic, subsequently sold approximately 4,000 ImClone shares for Stew- art, avoiding $45,673 in losses from the stock’s decline the following day. In 2004, Stewart was convicted of lying to investigators looking into the case. She was subsequently imprisoned for 5 months and was forced to pay approximately $195,000 in fines and penalties to the SEC. She was also barred from serving as a director of any public company for 5 years. Nonetheless, since leav- ing prison, Stewart has seen her company, Martha Stewart Living Omnimedia, grow well under her editorial direction.

Associated Press

In this 1987 photo, U.S. stock trader Ivan Boesky leaves court. Boesky was sentenced to 11 years in prison for insider trading.

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Stewart’s case is interesting. She did not gain from her insider infor- mation; she avoided a loss. This cre- ates a problem for ethical analysis. It is clear to see how trading based on private information before it is released into the public domain is a breach of trust or is simply unfair. However, using that information to avoid losses is a more complex issue. From classical moral theory, we could imagine that Kant would ask whether anyone in the same position as Stewart would have dutifully lost money. It seems a doubtful ethic to support.

Should insider trading be prohib- ited though? Free-market support- ers believe that it should be legal to trade information, while oppo-

nents claim that using privileged information is unfair and enriches some people while others lose out. We will compare those two positions next.

The Free Market Perspective

Free market supporters argue that insiders are doing the public a favor and they should be supported and encouraged. Indeed, the free market economist Mil- ton Friedman proclaimed that you cannot have enough insider trading, on the grounds that insider trading is the very nature of the investment world. If the SEC could ever shut down the insiders, the fear is that an important source of so much finance and investment information would go with it (Murphy, 2011).

From this view, insider trading laws are barriers to trade that should be repealed. In effect, the SEC’s interven- tions and threats upset the free flow of information that permits traders to get a better idea of where the hot deals are. The laws also provide the government with too many powers in trying to regulate dealers. It is far better to permit insider trading and to reward those who dig up useful information, which is inevitably shared quickly once they start buying or selling stock. That is, the market will produce “insider watchers” who trail the stock purchases of the known insiders, just as celebrity gossip columnists may trade tidbits with each other.

What Would You Do?

You hear from an insider that a com- pany in which you hold stock is about to be fined a billion dollars by regula- tors for breaching the country’s envi- ronmental rules. The stock is bound to fall, and you could sell now and buy the stock back cheaper in a few weeks.

1. Should you knowingly accept the loss, or do you think that anyone with that information would try to protect their own interests?

2. Would your decision change if you were told privately that stock you were about to purchase was due for a fall?

3. Can you be guilty of not buying stock today, given that informa- tion, or should you proceed with your original intent, buy the stock, and suffer a fall in values?

Associated Press/Bebeto Matthews

In this 2004 photo, Martha Stewart is shown leaving a federal court. Stewart was convicted of lying to investigators. She was imprisoned for 5 months and forced to pay $195,000 in fines and penalties to the SEC.

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Instead of laws, companies should look to their own contractual agreements with employees not to disclose or to benefit personally from information generated in their employment. Such nondis- closure contracts are quite common in the security and computer industries, for instance, where clients’ private information and companies’ proprietary knowledge are vital. In such instances, selling or exploiting private data or technical information breaches contractual obligations and the ethical principle of loyalty and trust.

An Issue of Fairness

The common argument against insider trading is that it is immoral on the grounds of fairness (Dal- ley, 1998). Insider trading is like giving a sprinter on the starting blocks a head start. It is not fair that an individual who is privy to some information may profit from knowing something that the rest of the public does not.

Secondly, acting on inside information is a breach of trust, even when there are no contractual agreements on nondisclosure. Even though the party acting on the information may not be legally an insider, someone in the company had to have passed the information along. That agent’s action is unethical, for it breaches professional trust and honesty.

Thirdly, there is evidence that clamping down on insider trading removes some volatility from the stock market, which in turn raises the appeal to proper investors to place their money into the markets (Padilla & Gardiner, 2009).

For many, it remains an issue of fairness plain and simple. However, when looked at closely, insider trading cases can be very complex. Much of the debate that is generated by politicians and lawyers tends to be overly simplistic and ignores economic research on the advantages to insider trading.

Legal Theory of Misappropriation

U.S. law also prohibits insider trading under the legal theory of misappropriation, which lower federal courts have tended to use since the 1980s and which the Supreme Court adopted in the case of United States v. O’Hagan in 1997. James O’Hagan, a partner in a law firm, used private information concerning one of his firm’s clients, Grand Metropolitan, which was considering an acquisition of Pillsbury. Hagan proceeded to purchase stock options without telling his firm; he profited to the tune of $4.3 million. The court ruled that any security trader who fails to dis- close personal profits gained from such exclusive information is acting deceptively by abusing the source of information. In effect, the court ruled that O’Hagan misappropriated information (United States v. O’Hagan). Misappropriation can also occur when a journalist discovers private information concerning the company and then acts on, or passes on, that information for com- mercial gain, a principle that echoes the contract of nondisclosure. However, the O’Hagan case has not completely standardized the issue of insider dealing, as what constitutes misappropria- tion remains a complex issue.

The problem is that profiting on the information is not always a certainty. Any investment car- ries with it a risk that the information used may not turn out to be so profitable after all—the market may discount the new information as it reaches the public’s ears. Alternatively, if the

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CHAPTER 7Section 7.5 Rogue Trading

information is profitable, others may get wind of the private channels of information used and follow the leads assiduously, as gossip magazines follow the lives of celebrities. In other words, if someone is making it rich quickly, others will dig around to find out how he or she is doing it. Indeed, any officers or managers of a company holding more than 10% of its shares must disclose their purchases of the com- pany’s stock to the SEC on Form 4, and their activi- ties can attract investors’ interest. After all, if a director, who has a much better knowledge of the company and its prospects than does a stock analyst in a different state, starts buying the company’s shares, most would believe that the action indicates some good news in the pipeline. But it is not always about buying stock.

Nonetheless, in the meantime the courts continue to work out the relationship of the SEC’s rules on insider trading to create a standard definition. As one legal scholar summed it up, “In so doing, they take their places in the ranks of jurists through the centuries who have wrestled with the question: ‘When is it unlawful to buy or sell a thing when you know some- thing the other party doesn’t?’” (Dalley, 1998).

Insider trading is a slippery eel that lawyers will con- tinue to wrangle over, but rogue trading is a more obvious form of fraud. When a rogue trader is discov- ered, the losses can be in the millions and companies can fall spectacularly. We look at this next.

7.5 Rogue Trading In 1994, Joseph Jett was discovered to have made false trades worth $330 million for Kidder, Peabody, and Co., a subsidiary of General Electric. It was the largest trading loss up to that time. In 1995, Toshihide Iguchi was indicted for rogue trading in the Daiwa Bank of Japan from its Wall Street offices. Over a period of 11 years, he had made over 30,000 unauthorized trades and had lost the bank $1.1 billion. More recently, in late 2011, Kweku Adoboli was arrested and accused of rogue trading after the Swiss bank UBS revealed that it had lost $2.2 billion. But the most “glamor- ous” was Nick Leeson, whose rogue trading brought down a prestigious British banking firm.

Similar to inside dealers, a rogue trader works within a company, usually in an investment com- pany or division. Rather than profiting from using private information held by the company to buy shares and their derivatives, rogue traders abuse the freedom they possess to profit from the company’s resources that they have been entrusted with. In an investment company, an employee can be provided with a trading account and a job to enhance the profits. However, the rogue gets

What Would You Do?

You hear from a good friend news of a tragedy, about to be announced in the morning, involving the listed company that he works for. A gold mine in Peru that was securing several tons of the valuable metal collapsed, killing several people. The mine itself will be closed for a year at least, and compensation claims may end up shutting down the facility completely. You have a chance of making a lot of money on the infor- mation by selling the stock and buying derivative options, which make money as the stock price comes down. The information is being held from the pub- lic until next of kin are informed.

1. Should you act on the information, or would you deem it immoral to earn money on the deaths of the miners?

2. If you chose to sell, on what grounds would you justify your action?

3. Would your decision alter if the disaster involved the deaths of hundreds of people?

4. Is there any kind of information that you believe people should not make money from?

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CHAPTER 7Section 7.5 Rogue Trading

carried away and begins dealing secretly, seeking to cover up mistakes and losses by manipulating deals. The fiduciary trust that exists between the corporation and the employee is then broken.

Rogue trading is exceedingly costly, and corporations have a strong incentive to ensure that their employees do not overstep their bounds. For instance, line managers check their deals and returns and regularly audit the balance book. However, some, perhaps given more trust than others, can run up massive debts.

Example of Rogue Trading: Nick Leeson

One of the most famous rogue traders was the Englishman Nick Leeson, whose actions brought down an old, well-established investment company, Barings Bank, in 1995. Barings was founded in 1792, helped finance the Louisiana Purchase from France in 1803, and rose to prominence with the British establishment. Queen Elizabeth was banking with Barings when Leeson effectively bankrupted the company.

Seen as an innovative whiz kid, Leeson was entrusted by the bank’s managers in London to deal in Japanese futures. Futures are contracts to buy and sell stock or commodities now for a future delivery date. Their prices can fluctuate wildly as trad- ers take positions on whether they believe prices of the stocks or commodities will rise or will fall. In his newly created position as head trader in Singapore, Leeson came across an obscure Barings account named “error account 88888,” into which a previous employee had shifted losses of 20,000 pounds. Rather than report it, Leeson began to use the account to channel the losses that he was incurring from his trading.

His job was to turn over contracts in a very short term, a simple task that would net very little money per trade even on large contracts. But he reasoned that he could net more if the contract were held for a lon- ger period and the market rose at the same time. Lee- son held onto his contracts in the hope that the prices would rise, but the market turned against him, and the Kobe earthquake of January 1995 sealed his fate. He had bet on the Nikkei index rising; it fell (Ball, Chap- man, & Cross, 1999).

As head of his trading team in Singapore, Leeson also had a conflict of interest, since he was in charge of auditing his own position—the managers did not want to incur higher expenses in splitting his position. When he made losses, he was able to report them as profits; as he commented about his supervisors, “peo- ple at the London end of Barings were all so know-all that nobody dared ask a stupid question in case they looked silly in front of everyone else” (Leeson, 1996,

Associated Press/Anat Givon

In this 1995 photo, a bottle of Leeson Lager is displayed, showing Nick Leeson under arrest in Germany after he fled Sin- gapore. The bottle refers to the amount Leeson lost (“US$ 1.4bn Proof”) and the secret account he used to hide his crimes (“88888 Reserve”).

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CHAPTER 7Section 7.6 Conclusion

p. 38). That is, his supervisors failed morally. They preferred to maintain the appearance of profes- sional integrity and banking solidity than to inquire too closely into the daily routines of the com- pany. The losses eventually totaled $1.4 billion—more than the company’s assets and reserves. Barings filed for bankruptcy.

Leeson’s account is instructive. While he was doing well, he was given more trust. But that was not balanced by the removal of the conflict of interest he had as head of his department or by the addition of other auditors. His supervisors failed to hire an auditor for his department, and they preferred not to look stupid through asking relevant questions. The flexibility and trust Leeson initially possessed turned into a greed for beating the market.

What Can Be Done?

Are Leeson and other rogue traders to blame, though? Part of the problem lies with manage- ment. As one commentator has put it: “What makes a rogue trader? The real answer is—a terrible accounting system, reporting system, and lack of internal control. It is actually a management problem” (Hutchinson, 2011). Corporate culture, for such critics, creates the environment in which rogue traders can gamble beyond their official responsibility (Davis, 2011). Employees may feel powerless to stop their rogue gambling when management and reporting are lax, which empha- sizes the need for clarity of purpose and checks and balances in a corporation to ensure that each employee knows the line managers and avenues of complaint or concern.

On the other hand, it can be argued that rogue trading is relatively rare, and the cost of imposing on employees a system of rules and reporting procedures may be the loss of their trust. In financial reporting, accountancy, auditing, and so on, professionals expect to hold the trust of their employ- ers: Their education and professionalism imply a status that should be respected. Accordingly, although there are a few who will abuse their trust—just as there are medics and lawyers who will do so—financial professionals should be allowed to retain the freedom to act as they choose.

7.6 Conclusion Part of the problem concerning the ethics of the finance world is the technical difficulties in understanding whether an unethical action is in fact taking place, and if so, whether it is deeply problematic enough to warrant government or legislative intervention. Companies can legally use creative accounting to shift funds around, to ensure that their tax burden is minimized as well as to increase their funding for asset acquisition, but they morally and legally should not be writing in funds and assets that are not there. While there may be a gray area between creative and fraudu- lent accounting, financial officers retain a duty to be conservative with estimations of value. There are enough ways of making money legally, rather than illegally, and those who do step into illegal procedures fall afoul of the law and potential shareholders and investors.

Professionals can be given freedom and responsibility, but that does not mean that they should go unsupervised and without independent auditing of their positions and accounts. Nick Leeson broke Barings Bank because the bank did not want to pay for supervision. Just as with govern- ment, it is vital to ensure that there are checks and balances against personal greed and incompe- tence, and that always comes at a cost.

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CHAPTER 7Summary

Summary In this chapter we saw that white-collar crime as it relates to financial and accounting practices can be highly expensive. Financial reporting, we noted, is not an objective science, for values allot- ted to corporate assets are ultimately subjective. This means that financial officers often act in a hazy area in which undervaluing or overvaluing a company’s assets and liabilities can have moral as well as market implications. A temptation is always present to represent a company in a good light to secure funding or to advance its interests and profits for a host of reasons.

Financial officers, auditors, and accountants should act conservatively in their evaluations and should note financial discrepancies; but sometimes the temptation or the commands from man- agers can override professional values and legal considerations, as when companies use transfer pricing to enhance their turnover. While it seems reasonable for financial officers to shift funds into countries with lower taxes, we asked whether their actions are ethical. By avoiding tax payments in host countries, they are depriving those countries of sometimes critical funds to help them develop.

The morality of the law in financial and related cases is often confusing, too. There is the ongoing debate on the morality of insider trading, for instance, with proponents claiming that insiders help information flow and opponents arguing that insiders act unfairly.

Finally, we reviewed the problem of rogue traders who break the trust that managers place in them, and who can run up huge debts. While rogue traders are rare, there is a clash between accepting professionalism and an appropriate freedom of action and scrutinizing their every move.

Discussion Questions

1. Henry Manne believed that companies cannot become too incompetent or corrupt, as eventually their share price would fall and they could be taken over by another firm that would get rid of incompetent management. Adolf Berle and Gardiner Means believed that company managers have an incentive to feather their own nests and to undermine share- holder wealth. Using examples, which theory do you think best fits American companies?

2. Financial reporting is a complex procedure that can affect company status and investment opportunities. When a company overstates the value of its assets, it has the potential to tap into new funding or to acquire other businesses. To what extent do you think financial officers should encourage a rosier view of the company, compared to a pessimistic view?

3. Insiders are people who are legally and prominently connected to a listed company; if they act on information that is presently private, they are committing a crime, according to the SEC. Some theorists believe that insider trading laws are illogical and impede the flow of information, making investors wary of police action against them. Outline the SEC rules on insider trading and, using an example of recent insider dealing problems, discuss whether the rules make ethical sense.

4. Rogue trading occurs when an employee takes advantage of financial powers entrusted to him or her. Compare a couple of examples of rogue traders, evaluating whether the blame lies with the corporate culture or with the gambling of the trader. In your evalua- tion, also consider whether traders’ freedom to act should be limited, and, if so, whether such limitations would be an insult to their professionalism.

5. White-collar crime costs the American economy around $300 billion annually. For some, the violation of fiduciary professional trust is a heinous crime that warrants strong

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CHAPTER 7Summary

penalties in order to make an example of people who would break the trust of corpora- tions and the public. Should the professional status of such criminals attract harsher sen- tencing, compared to sentences for other crimes such as robbery and violent assault?

Key Terms

caveat emptor Latin expression meaning “buyer beware,” expressing the theory that consumers are responsible for their purchases.

conflict of interest When a person has two or more conflicting loyalties that can compromise their impartiality in working for a business or preparing a report.

cooking the books A general term describing the use of illegal accounting methods to exag- gerate incomes or to hide losses.

creative accounting Legal use of accounts to shuffle funds around a corporation to make it look stronger or more profitable.

fiduciary trust The trust that nonprofession- als have in the finance and accounting profes- sion that members of that profession will act properly.

Financial Accounting Standards Board (FASB) An independent board set up by the financial industry to promote standards.

Generally Accepted Accounting Principles (GAAP) The standards formed by the finance industry on accounting and financial reporting.

impartial oversight The ethical mindset of tackling a problem or reviewing a business situation without any self-interest involved.

insider According to the SEC, any company officer, director, or shareholder owning more than 10% of the company’s stock.

insider trading This occurs when an insider, as defined by the SEC, trades on information which has not yet been made public. Insider dealing is illegal, although ethicists debate whether it should remain illegal.

rogue trader An employee who abuses the trust given to him or her and uses company funds for personal profit or covers up losses using secret accounts is a rogue trader.

Sarbanes–Oxley Act of 2002 U.S. federal law to encourage greater transparency in corpo- rate financial reporting.

Securities and Exchange Commission (SEC) The Securities and Exchange Commission was set up in 1934 to oversee and regulate the securities and exchanges industry in the after- math of the Great Wall Street Crash of 1929.

Securities Exchange Act of 1934 U.S. federal law that set up the SEC to oversee the financial markets.

tax avoidance The legal use of accounting practices to reduce a tax burden.

tax evasion The illegal hiding of money earned to reduce a tax burden.

transfer costing Shifting funds across a cor- poration, particularly a multinational one, to decrease a tax burden.

transfer pricing A method of making a corpo- ration look more profitable by selling goods or services across the corporation. If a company sells another division a service, this can be booked as revenue, so if the “price” charged is inflated, the company’s revenues can be made to look better than they are.

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